August 26, 2016

"Expensive" US Banks Are Global Outlier As 'Yield Curve' Inverts For First Time Since Lehman

12-months US Libor squeezed higher in anticipation to changes in US regulation on prime money-market funds, kicking in on October 14th. However, Fasanara Capital's Francesco Filia warns that critically, it is unclear whether such technical factors will fade, partially or in full, once the new regulation kicks in and uncertainties clear. Coincidentally, rates on short-dated govies also moved higher in past weeks in anticipation of potential rate hikes by the FED.

In addition to the tighter financial conditions in the inter-banking market that the squeeze on swap rates implies, to domestic and foreign users (as also reflected by TED spreads and OIS/Libor spreads being the widest since 2011), we note that Libor rates are now close to long dated US rates, resulting in a much flatter yield curve.  

Interestingly, the US yield curve is now flat between 12months Libor and 10yr Treasury yield,  for the first time since 2008.

The funding squeeze on Libor rates might prove temporary, but even then the US curve remains very flat: the spread between 10yr US Treasuries and 2yr US Treasuries is the tightest in years (at ~80bps) and on a multi-years declining path.

The shape of the yield curve is a major driver of profitability for commercial banks: the flatter the curve the least profitable its traditional core business of borrowing short-term/lending long-term.

The low level of interest rates is a major driver of profitability for all banks, not just commercial.

Banks’ main commodity is interest rates, so much as oil is the main commodity for oil companies: the lower the level of interest rates the least profitable its core and non-core businesses (fees, carry, bid-offers, trading, liquidity providing are all affected).

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